Virginia’s Economy Has a Diversification Problem

Anyone who has sat through agonizing hours of Northern Virginia traffic has experienced first-hand the hustle and bustle of a self-proclaimed economic powerhouse. Anyone who has traveled to Richmond and gawked at highrise after highrise quartering yet another Fortune 500 company has seen the successes of a state economy as red-hot as any other in the nation. At first glance, the Commonwealth of Virginia appears to have nurtured a business environment that rivals the most historically successful American state economies. After all, it ranks fifteenth nationally in GDP per capita at $51,736, just behind powerhouses like Colorado, Texas, and Illinois. Back in 2006 and 2007, the magazine Forbes went so far as to call Virginia the country’s most appealing climate for business. Ten-odd years later, one wouldn’t expect a gubernatorial candidate to center his campaign around solving the “significant challenges” facing the state economy, as Ed Gillespie did this last year. As it turns out, Virginia’s economic situation is well-suited to support Virginians for the time being, but in taking a long-term view, some serious problems become apparent. Virginia’s reliance on federal contracts and military base funding as major economic sectors has supported and will continue to support a robust economy in the short run as Congress acts to raise military spending caps. Ensuring long-term economic health, however, will require whichever party controls state policymaking to make diversifying our private sector and developing our infrastructure top priorities.

From the early 2000s until the dawning of the Great Recession in 2007, Virginia’s economy was booming like few others. Northern Virginia underwent an explosion in activity, as its population grew a whopping 23% from 2000-2010, compared to a 9.4% national average. Even with this massive growth in population, jobs were by no means hard to find. Even in the depths of the recession in September 2008, the Northern Virginia economy saw job growth of 1%, while the rest of the country saw job markets contract by -0.5%. So why did Northern Virginia see such high levels of growth in during the first decade of the 2000s, and how did it come out of the 2007 crash relatively unscathed? To stay financially healthy during a recession, demand for workers and investment needs to come from somewhere. For Northern Virginia, this influx of money came from the federal government. Between 1980 and 2009 it saw almost $400 billion in federal funding dumped into the region, federal contract money that went to “space rental... and personnel services… [which was] re-spent generating further positive economic impacts across the breadth of the local economy.”

This was an economic windfall of titanic proportions for the region. Even during the opening years of the Great Recession, the area benefited from a relatively reliable income flow as government funding continued to increase. Northern Virginia’s economy inevitably performed well during this period, and federal spending provided over 37% of the area’s total economic output in 2010. However, when a regional economy depends almost entirely on one organization to finance it — especially an organization with such schizophrenic management as the federal government — fiscal stability can be lost in the blink of an eye. No time was this more clearly evident than in the aftermath of the sequester, when budget talks broke down and Congress enacted a last-ditch round of spending cuts in 2013. Federal spending on the defense and non-defense sectors that Northern Virginia relied so heavily on was slashed by about 8% — a $1.1 trillion loss in funding over the course of the cuts. The Northern Virginia economy became sluggish, and Virginia’s real GDP growth fell from a healthy rate of 2.3% in 2010 to complete stagnation in 2013.

Northern Virginia’s symbiotic relationship with the federal government is not, of course, the sole engine of the Virginia economy. Another hub of the state’s economic lifeforce lies in the Southeastern Tidewater, in the area of Norfolk, Newport News, and Virginia Beach. Just like Northern Virginia, the Tidewater economy hangs its hopes on money from the federal government, specifically funding for the massive shipyards in Newport News and the naval base in Norfolk. About 160,000 of the area’s 765,000 workers are employed by the government, and the region depends on the activity generated by the naval base to be successful.

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The above graph, courtesy of ODU’s 2017 “State of the Region” report, illuminates a deeply disturbing trend. Here we can see that the Norfolk region was spared the negative effects of the recession for a short while, longer than most of the nation. However, once sequestration took hold, the region’s economic fortunes began to lag far behind Virginia and the country as a whole. The spending caps that sequestration put into place were recently removed by a bipartisan budget deal, but the Norfolk area’s long slog back to economic health clearly displays the pitfalls of the region’s dependence on federal spending.

For a jarring glimpse of what happens to a region when it loses its main source of economic success, look no further than Southwestern Virginia. As the decades-long decline of the coal industry continues, that corner of the state continues to cling to its tourism revenue for survival. Of course, these two situations are not even close to direct comparisons -- the federal government isn’t going to suddenly disappear or go bankrupt anytime soon. It does, however, emphasize the point that when a region or state nails its economic wellbeing to a single source, there is always a high level of risk. Northern Virginia can directly trace two-fifths of its economic activity to federal spending, and the Commonwealth of Virginia depends on Northern Virginia for two-fifths of its economic activity. The state’s other economic hub, Hampton Roads, rotates around a federally-funded naval station that could be in real trouble if the Base Realignment and Closure (BRAC) process spins up in a future period of tight federal budgets. The BRAC commission, created to ensure that military base closure decisions are made free from undue political pressure, could see fit to downsize or even shutter that station if future considerations demand it. It would be no stretch to say that the economic health of the state is inextricably linked to healthy government funding. Former Virginia Gov. Terry McAuliffe alluded to this point when he addressed the State Assembly in 2014 and lamented that the sequester had “dealt a severe blow to our economy and our confidence in the future.” So where do we go from here?

Should Virginia focus on cutting taxes to make our business environment more attractive? Ed Gillespie, the Republican candidate for VA Governor this past fall, correctly identified in his campaign platform that “Virginia suffers from a ‘company town’ syndrome, with the federal government in the role of the dominant company.” However, his main suggestions for how to deal with this issue were to slash state income taxes and relax state regulations. While the case could certainly have been made that this would positively affect private-sector economic growth in the short term, I strongly disagreed with the idea that this was Virginia needed. Another ODU report on “The State of the Commonwealth” identified Northern Virginia’s traffic as a significant challenge to the area’s future economic success. Their report emphasized the fact that “in order to transition to a new model, Northern Virginia must be an attractive place for talented workers to live and work.” In a state that already has significant revenue issues, further cuts to revenue will make highly necessary infrastructure development nearly impossible, hamstringing Northern Virginia’s ability to maintain the advantage in human capital that has helped it succeed for so long. If economic development is the goal, then tax cuts should be a last resort when there are so many sectors in need of government action.

Instead of pursuing an unfocused agenda of general tax cuts, Virginia must focus its future economic plans on growing a robust private sector that takes advantages of the state’s natural economic advantages. The recent explosion of data centers in Loudoun County serves as a fantastic example of an industry that is well-suited to the area around it. As of 2016, an astounding 70% of the world’s internet traffic flowed through Loudoun County, and power rates were significantly lower than the typical national rate. This means that data centers can not only be a significant source of private economic development for the area, but also for the larger internet sector as a whole. The area has already been dubbed the “Silicon Valley of the East” by some, and that title underlines the real potential that the tech industry has to revolutionize the Northern Virginia economy. In another part of the state, Western Virginia has been able to use its natural advantage in land and climate to establish a $1.4 billion wine industry. The sales and tourism that have sprung from this relatively new industry have helped to offset some of the decline of the coal industry in that area. These two new booming industries show how the state’s business atmosphere can benefit from leveraging the advantages inherent to Virginia.

For 20 years, Virginia has been able to surpass most of the country in economic success simply by virtue of its proximity to Washington, D.C. The Great Recession and the federal spending cuts that followed pulled back the curtain on the financial uncertainty underlying the state economy and highlighted the need for a robust, diversified private sector. As federal deficits hit $20 trillion and continue to grow, it is becoming more and more apparent that federal expenditure cuts will likely be enacted again in the not-too-distant future, and Virginia needs to be ready when they are. Instead of engaging in corporate welfare to attract Fortune 500 headquarters to Richmond, or enacting poorly thought-out tax cuts, state policymakers need to make real efforts to identify and nurture industries that can take advantage of Virginia’s existing comparative advantages. Infrastructure development and education will be key to the state’s future as a destination for top-tier talent. If action isn’t taken, Virginian livelihoods will continue to depend on the whims of a dysfunctional US Congress. If managed correctly, Virginia’s economy can continue in its role as a national leader for a century to come.